Credit cards are a great way to build credit, finance a purchase, and in some cases, even pay down debt. But despite their advantages, credit cards have become a big problem for many Americans, who sometimes use these valuable tools to make poor financial decisions and get deeper and deeper in debt.
Today, Americans owe more than $1 trillion in credit card debt, according to the Federal Reserve. Compared to student loan debt, which just topped $1.5 trillion, debt is a big concern for many borrowers, who often struggle to make their monthly payments and may be considering credit cards to reduce debt or pay off their loans completely.
But are credit cards a good solution to your student debt problem? If you’re thinking of using credit cards to repay your student loans, our experts have put together a simple guide to help you decide.
While private lenders may give you the option to repay your student loans with a credit card, federal student loan servicers like Nelnet, Great Lakes, Navient and FedLoan only allow you to make payments from your checking or savings account. Unless, of course, you use an intermediary.
An intermediary is a business that will make a payment on your behalf and charge the payment to your credit card. However, by sending your servicer a check, an intermediary will also tack on a transaction fee as part of the payment process. One example of an intermediary is Plastiq, which charges a standard fee of 2.5% for these types of transactions.
If you’re having trouble putting together enough money for a monthly payment, this may be a good option. With the average student loan payment being $200 to $300 a month, it’s a small price to pay to avoid student loan default. But it can also add up quickly if it becomes your go-to solution.
Here are a couple of reasons you might want to use a credit card to pay your student debt.
Credit cards typically charge anywhere from 15-18% in interest annually versus 5-7% on student loans, which often makes them a bad choice for repaying student debt. However, if your credit card company sends you a zero-interest balance transfer offer, you could save a lot in interest – until the offer runs out.
Because zero-interest balance transfer offers are only good for a limited time, they’re best suited for smaller loan balances. If you feel you can repay your entire credit card balance in the 12 to 18-month timeframe offered by your credit card company, you’ll save a full year’s interest by doing so. If this doesn’t seem financially possible, you should consider other options.
Some credit cards offer cashback rewards for using the card. On student loans, however, this may not be the best option, unless your card’s rewards offer better cashback incentives than the 2.5% charged by intermediaries.
If you’re lucky enough to have a card that offers more than the interest fees intermediaries charge, then charging student loans to your credit card could help you rack up a lot of points for travel or purchases. Combined with a zero-interest balance transfer offer, this approach could be even more beneficial. The trick is knowing you can pay down your debt before the offer expires and interest rates soar.
Here’s why using your credit card to pay your student loans might be a bad idea.
When you use a credit card to make a big purchase – or pay off your student loans – you could take a huge chunk out of your revolving credit line that will impact your score. For example, if you have $10,000 in open credit and you use a majority of that to repay your loans, your credit utilization score will likely drop as a result.
Credit utilization scores make up 30% of your total credit score. When this score is impacted, it can bring down your score significantly. The only way around this is to pay back the full balance as soon as possible. Otherwise, credit card companies could see you as a risk, and rank your credit worthiness accordingly.
Credit card companies are largely unforgiving when it comes to missed or late payments. When financial issues arise, your credit card payments are still due, and there’s often very little wiggle room on extending your payments or getting borrower protection.
Federal student loans, on the other hand, offer a wide range of repayment, forgiveness and other financial options that can get you out of a financial bind. These other options include student loan deferment, working in a profession that offers loan forgiveness, and student loan consolidation – which can put payments on hold for a specified period, eliminate your loans completely or simplify the repayment process.
Instead of credit cards, the Department of Education offers several income-driven repayment programs that can make payments more affordable and manageable for borrowers. These include:
These programs base your monthly payments on your discretionary income, giving your more financial flexibility than the standard repayment plan. If you have multiple loans, you might also consider consolidation as an option. For many, making one payment a month instead of multiple payments can make all the difference.
Before you pull out your credit cards to repay your debt, be sure to speak with a student loan expert to explore other options. Our specialists can walk you through multiple repayment plans and loan alternatives that can help you get back on track. Simply fill out our online form or call (800) 771-6358 to get started!